Why Anti Price-Gouging Laws Don’t Work

When prices go up as a result of inflation or an increase in demand, there is a tendency for economic ignorants to call for what they see as the most common sense solution: use government to prevent companies from charging over a certain amount for a product. It’s typical for those who lack an understanding of an issue to choose a solution that deals only with the symptoms and not the cause.

To understand why controlling prices doesn’t work you have to first understand that consumer demand influences prices, and prices have an effect on how many units of a good will be produced. Producers will continue to produce more and more units of a good until it ceases to be profitable to produce additional units. So, having the producers think only of their potential profits actually helps in that the right amount of units are produced, based on the need of the consumers. It wouldn’t be beneficial for the economy to have producers either produce less units than are demanded, as some consumers would be left unsatisfied, or produce too many units of a good, as that would be a complete waste of time and resources, that could have been spent on products that people actually needed.

Let’s use an example of an unexpected increase in the demand for a product. I remember a town in Massachusetts not too long ago found that their water was contaminated. This resulted in an increase in the demand for bottled water, which resulted in people getting angry and accusing the sellers of “price-gouging.” What happens, though, if the sellers are prevented from raising prices?

Since the demand of the good is high, consumers would purchase even more units of the good than they really need, and since there is no monetary incentive for the increase in production, a shortage of the good would result, leaving many consumers who do need the good and are willing to pay for it, without any bottled water, in my example. So, we end up with some consumers who bought more water than they really needed, and some who really did need the water but couldn’t find any to buy.

On the other hand, if the government stays out of the way and allows the price to increase, it creates an incentive for everyone to produce more units of the good. The increase in price would send a signal to others that the bottled water industry, in my example, is a very profitable one to enter at the moment, which would result in more sellers of the much needed good. Essentially, what happens is that when consumers indicate that they need or want more of a good, the market responds by producing more units of that good.

This is what those who speak of “greedy” businesses don’t understand. The fact that businesses want to make the most amount of money possible, is exactly what allows consumers to have the upper hand. Consumers are the ones that decide what will be produced in the economy, in a free market. They have the money. Producers want that money, and in order to get it, they have to listen to the wants of the consumer. When price ceilings are instituted, capital and labor are actually driven out of the controlled market and into other goods that are not price controlled.

If the price of a good increases because of inflation and price ceilings are instituted by government, even less of the good would be available. Some producers would actually stop selling the good altogether, since at some point it would cease to be profitable to continue production, because of the rising costs to produce additional units.

Price controls, like many other government ideas, have the opposite effect. If we want more of a good to be available to consumers, the last thing we want is to interfere with the market prices. This should be common knowledge, but for some reason, many think they can repeal the laws of economics.

Most politicians get into politics because they like power, and  they just cannot accept that it does not matter how important they are, they can’t just pass a law that goes against economic science and have it work.

Similar Posts:

  • Price controls invariably lead to the scarcity of products.

    • Yeah, or an abundance of unsold products in the case of price floors (e.g., minimum wage).

  • Ray

    It also occurred to me that resorting to price controls in the event of emergencies also disincentivices would be entrepeneurs to build the capital goods to take advantage of such emergencies

    • That’s a good point. It would certainly be demotivating to producers of emergency goods to know that the government would get in the way in emergency situations.